Safer Mortgages Rise From the Ashes of ’08 Financial Crash

Safer Mortgages Rise From the Ashes of ’08 Financial Crash

Mortgages are safer now than they were 10 years ago. That’s the main effect the 2008-09 financial crisis has had on the mortgage market.

The following loan types were popular during the housing boom in the early- to mid-2000s but are unavailable now to most borrowers:

Low-doc mortgages allowed borrowers to get loans without documenting income and assets.

Interest-only mortgages enabled borrowers to buy houses they otherwise couldn’t afford with an initially low monthly payment. But the loans were the financial equivalent of time bombs: The interest-only period expired after a few years, and then borrowers had to pay principal, catapulting monthly payments past many owners’ ability to pay.

Subprime mortgages — home loans for borrowers with poor credit — zoomed in popularity, going from 8% of mortgages in 2003 to 20% in 2005 and 2006.

You don’t have to be an expert to see how a lot of those loans could go bad. But somehow investors were surprised when large numbers of borrowers stopped paying their mortgages. By September 2008, 5.3% of mortgages were delinquent, meaning 1 in 19 borrowers were at least 30 days behind on payments. In the first quarter of 2010, the delinquency rate topped out at 11.54%, meaning about 1 in 9 borrowers were late on their house payments.

Millions of those delinquent borrowers lost their homes. From 2007 through 2016, almost 7.8 million foreclosures were completed, according to CoreLogic. The homeownership rate decreased, and it hasn’t recovered. In the second quarter of 2008, 68.1% of households owned their homes; 10 years later, 64.3% did.

Stopping it from happening again

According to a recent NerdWallet survey, conducted online by The Harris Poll among over 2,000 U.S. adults, nearly 4 in 5 Americans (79%) experienced negative financial impacts due to the financial crisis; among them, more than half (55%) said they still have not recovered financially.

And people are still traumatized by the foreclosures. In the same survey, 31% of respondents said the financial crisis would make them more conservative when estimating how much home they can afford, and 24% said they would need a larger down payment if they were to buy a home now. In addition, 7% of Americans said they delayed homeownership as a result of the financial crisis. For those under age 35, the figure was 13%.

To prevent a recurrence of the housing crisis, legislators and regulators created rules that limited the availability of exotic mortgages, and regulators and advocates created tools consumers can use to get a safe mortgage.

Get a loan you can afford to repay

Even with these new regulations and consumer-friendly tools, it’s still up to you to inform yourself and know your limits. Here are some strategies.

Know what you can afford. The first step toward getting an affordable mortgage is buying an affordable home. A home affordability calculator helps you figure out your price range before looking at any houses.

Home affordability was another casualty of the financial crisis. In NerdWallet’s survey, 12% of respondents said they worry that they won’t be able to afford to buy a home as a result of the financial crisis. And 19% said their salary has been stagnant since the financial crisis.

Get preapproved for a mortgage. A preapproval gives you an even more accurate picture of how much you can afford to borrow. Getting a preapproval gives you experience collecting your documentation, which you’ll have to do when you later apply for the mortgage. This marks a change from the early- to mid-2000s, when borrowers didn’t always have to document their income and assets.

Keep debt payments under control. When you apply for a mortgage, lenders pay close attention to your debt-to-income ratio, or DTI. It’s the percentage of your monthly income, before taxes, that goes toward your debt payments.

A rule of thumb is to hold your DTI to 36% or below, even though lenders may allow you to borrow up to 43% or even higher in some cases.

How affordability standards have changed since 2008: After the Consumer Financial Protection Bureau was created in 2010, a top priority was reforming the mortgage business. The agency adopted an ability-to-repay rule governing mortgages that requires lenders to:

Verify income and credit information instead of just taking the borrower’s word for it. During the housing boom, lenders had allowed borrowers to get mortgages without providing proof of their stated incomes and assets. This rule placed those low-documentation loans off limits for most borrowers.

These guidelines seem like common sense, but the CFPB implemented the rules to prevent lenders from ignoring common sense during the next boom.

The CFPB made other changes, too, to make mortgages safer. Lenders had introduced an adjustable-rate mortgage during the boom called a payment-option ARM, which had a frightening feature: In some instances, borrowers could make minimum payments that didn’t even cover that month’s interest, so they ended up owing more on the loan, even after making a payment.

Under the CFPB’s qualified mortgage rule, those risky payment-option ARMs are no longer permitted. Neither are interest-only mortgages or home loans with balloon payments. And prepayment penalties are banned on most mortgages.

Compare mortgage offers

To make loan comparisons easier, the CFPB created a three-page disclosure called the Loan Estimate. Lenders must provide Loan Estimates to customers who apply for mortgages.

Use this Loan Estimate shortcut. Place two or more Loan Estimates side-by-side. Go to Page 3 of each Loan Estimate and focus on the “Comparisons” section, and specifically two numbers: how much the mortgage will cost in the first five years, and how much principal will be repaid in those five years. Those figures will clarify which loan is better.

How loan comparisons have changed since 2008: For decades, mortgage applicants received a disclosure called the Good Faith Estimate from their lenders. The document detailed closing costs, but it didn’t make it easy for borrowers to compare loan offers.

The CFPB believed too many mortgage borrowers wasted money by applying with just one lender. The agency figured that if it created a disclosure that made it easy to compare loan offers, more borrowers would apply at multiple lenders.

The CFPB replaced the Good Faith Estimate with the Loan Estimate in 2015 after a 4½-year development process.

Where mortgages are now

In September 2008, the federal government took over government-sponsored enterprises Fannie Mae and Freddie Mac by placing them into conservatorship. Ten years later they’re still in conservatorship, with little political pressure to reform them.

Some researchers argue that mortgages are too hard to get. According to the Urban Institute, “overly tight credit” prevented 5.2 million borrowers from getting mortgages from 2009 to 2014, plus another 1.1 million in 2015.

Credit standards have loosened, but slowly. The average credit score on all mortgages closed in August 2011 was 741, according to Ellie Mae. In July 2018, it was 725.

Unlike the precarious mortgages of the boom years, today’s mortgages are benign. But standards are stricter, and the best-qualified borrowers have low debt-to-income ratios and high credit scores.

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